While failure to file returns or pay correct tax can subject clients to heavy penalties, taxpayers who come forward can sometimes receive a break.

Under its policy of
voluntary disclosure, the IRS
can forbear from referring for criminal
prosecution taxpayers who come forward to
admit previously unreported tax
liabilities. CPAs may be in a position to
learn of clients’ intentions to make such
disclosures. Where disclosures could
otherwise entail criminal penalties, CPAs
should refer clients to a qualified
attorney in keeping with AICPA Statement
on Standards for Tax Services no. 6 and
for the attorney-client privilege
available.

Policies and
guidelines for voluntary disclosure
are contained in Internal Revenue
Manual section 9.5.11.9. To take advantage
of them, taxpayers must be willing to
cooperate with the IRS in determining
correct tax liability, which they must
arrange to pay, along with interest and
penalties.

Voluntary disclosure
treatment is not available if
the IRS has learned of the taxpayer’s
liability through the news media, an
informant, bank reporting or the fruits of
its own investigation. Also, voluntary
disclosure does not protect a taxpayer
whose unreported income was from an
illegal source.

Despite its potential
pitfalls, a properly managed voluntary
disclosure may be a valuable
strategy for taxpayers who otherwise could
face severe penalties that can in some
instances include incarceration.

Stephen G. Huggard, Esq.,
is a partner in the Securities, Government
Enforcement & Corporate Governance
Litigation practice group of the
550-attorney international law firm of
Edwards Angell Palmer & Dodge. His
e-mail address is shuggard@eapdlaw.com.

Every once in a while, a client with a
heavy heart visits a CPA. The client has not been
paying what he or she owes Uncle Sam and wants or
needs to come clean, but has no idea how to do so.
The good news is that there are ways to help your
client.

For more than 55 years, the IRS
has had a policy that can allow such taxpayers to
come forward and, in exchange for their
truthfulness and cooperation, escape criminal
prosecution. While the Service’s forbearance under
this voluntary disclosure policy is not ironclad
or available under all circumstances, it can be
determinative. “A true voluntary disclosure is
usually the deciding factor in decisions about
prosecution,” said Shirley D. Peterson, former IRS
commissioner, in a speech to the AICPA Tax
Division.

The bad news is that inexpert
advice can buy the client a lot of trouble,
perhaps even a stay in a federal penitentiary. CPA
tax practitioners who learn of an error in a
taxpayer’s return or the taxpayer’s failure to
file a required return should advise the taxpayer
of the error and measures to be taken. In keeping
with AICPA Statement on Standards for Tax Services
(SSTS) no. 6, if it appears the taxpayer could be
charged with fraud or other criminal misconduct,
the taxpayer should be advised to consult legal
counsel.

CRIMINAL PENALTIES POTENTIALLY SEVERE
The U.S. punishes tax evasion more
harshly than most countries. While anecdotal
evidence suggests that many more people cheat on
their taxes every year than are caught by the IRS,
those who are caught can be punished far more
severely than the public might realize. Federal
sentencing guidelines call for someone who evades
between $30,000 and $80,000 in taxes to be
sentenced to between 15 and 21 months in prison,
without benefit of parole. In addition, the
taxpayer will still owe the back taxes, interest
and penalties. Many Americans live with the fear
that the IRS somehow will find out the truth about
their tax returns. That fear can be paralyzing but
need not prevent a client from addressing the
issue head-on.

The IRS can be relatively
forgiving if taxpayers voluntarily disclose that
they have not reported all their income or have
not filed all their tax returns. In fact, the
Service’s policy encourages people to voluntarily
disclose their tax delinquencies in return for
consideration from the IRS in determining whether
criminal charges should be sought. The back taxes
and interest, however, will have to be paid in
full. This is good for the IRS, which after all is
in the business of collecting money. Almost
anything that encourages more people to pay more
money is good for it.

But why would an
individual ever make such disclosures? And what
does “relatively forgiving” mean? In answer to the
second question, a successful filing of a
voluntary disclosure may result in criminal
prosecution not being recommended, as long as it’s
not subsequently determined the taxpayer was
untruthful or uncooperative.

Taxpayers may
want to get right with Uncle Sam for several
reasons. Some people are bothered by their
consciences. Others are refinancing mortgages and
need to show accurate tax returns to the lender.
People may become embroiled in a nasty bit of
litigation with someone who knows their secret,
and they want to remove the leverage that such
knowledge provides the opposing side. Maybe they
are changing marital status. In any event, they
have come to realize that a criminal prosecution
is at least theoretically possible, and they want
to eliminate the threat from their lives.

WHEN DISCLOSURE IS VOLUNTARYUnfortunately for such people, the IRS’s
voluntary disclosure policy contains some strict
guidelines. The Internal Revenue Manual (IRM),
which establishes policies and guidelines for IRS
agents nationwide, makes it plain that the
disclosure must be both voluntary and timely
before the IRS will consider it favorably (IRM
section 9.5.11.9). In addition, the taxpayer must
show a willingness to cooperate with the IRS in
determining his or her correct tax liability and
make good-faith arrangements to pay all
outstanding taxes, interest and applicable
penalties. The taxpayer does not have to file
complete returns and make full payments at the
time of the voluntary disclosure; he or she just
has to make the IRS comfortable that both will
happen.

The disclosure must be made before
the taxpayer has come to the attention of the IRS
through independent means. If the taxpayer is the
subject of a civil or criminal investigation by
the IRS—even if the taxpayer does not know it—it
is too late to make a voluntary disclosure to the
IRS. If the taxpayer’s tax issues have been
brought to the attention of the IRS through a
third party such as an informer or the media, it
is too late. This category of “informants”
includes the taxpayer’s bank. If the taxpayer
deals with large amounts of currency, the bank may
well have filed Currency Transaction Reports or
Suspicious Activity Reports with the IRS. The IRS
considers these reports on a par with informants.
Conversely, if the IRS is examining a widely
promoted scheme in which the taxpayer participated
but the taxpayer himself or herself has not yet
come to the attention of the IRS, the disclosure
still may be timely.

The voluntary
disclosure should be made to the Criminal
Investigation office of the IRS and is best made
to a supervisory special agent, since it will be
evaluated by a special agent. There are hazards.
The IRS goes out of its way to underscore a lack
of guarantees in this area. Specifically, there is
no guarantee that, just because the taxpayer
discloses to the IRS, that the IRS will not seek
to prosecute the taxpayer. Therefore, before any
disclosures are made, a representative must
carefully debrief the taxpayer to ensure that
there are no issues that the IRS will already have
on its radar. This should be done by a qualified
attorney, to cloak the conversation in the
attorney-client privilege. Clients may well be
loath to admit in a nonprivileged setting some
aspects of their activities that have come to the
Service’s attention.

In the debriefing of
the client, before any disclosures are made,
counsel will best be able to determine whether the
taxpayer has engaged in activities that are likely
to be known to the IRS. If the IRS decides that
the information is not new to it, agents will
listen politely and then use that information
against the taxpayer, who will have dug a hole
from which he or she may never emerge.

Among other things, counsel must ensure that
the unreported income was all “legal source”
income—money made from lawful dealings. Dealers in
illegal drugs, for example, cannot benefit from
the voluntary disclosure policy. The taxpayer must
also be willing to disclose all entities that are
related to him or her. For example, if he or she
owns a string of restaurants, each separately
incorporated, the IRS will expect him or her to
identify each and to make sure that each set of
returns is up to date and accurate.

This
is not the time to be cute with the IRS. If it
decides that the taxpayer has been only partially
forthcoming, it is likely to view him with
suspicion and pursue any remedies it has,
including criminal investigation. The IRS expects
that people who seek shelter under the voluntary
disclosure policy will be fully forthcoming. At
the same time, the risks involved argue in favor
of having the communications come through the
taxpayer’s counsel, and not from the taxpayer.

AN “ALL-IN ” PROPOSITION
Anonymous disclosures are counter
productive. The IRM explicitly states that
anonymous disclosures are insufficient to warrant
favorable consideration by the IRS. Moreover, the
anonymous disclosures can prompt the IRS to begin
an investigation, thus precluding the possibility
of the taxpayer ever being able to voluntarily
disclose his or her issues. The taxpayer will
effectively have become a “third-party” informant
against himself. Taxpayers who think they want to
disclose to the IRS must understand that this is
an “all-in” proposition; they do not get to stick
their toe in the pool to test the waters. That
being said, the representative might well want to
have some exploratory talks with the IRS in which
the situation is described to gauge the agents’
reactions, with the understanding that until the
taxpayer’s identity is disclosed, nothing really
has happened and no protections can be expected.

As with most policies, some gray areas in
the voluntary disclosure policy should be explored
with caution. For example, the IRM specifically
states that the disclosure is not timely if the
IRS has received information about the taxpayer
through a criminal enforcement action such as a
search warrant or grand jury subpoena. It also
states that a disclosure is not voluntary when
made by a taxpayer who is under grand jury
investigation. The IRM does not specify that the
grand jury investigation has to be tax-related to
foreclose the disclosure. In fact, many grand jury
investigations uncover tax issues that are never
shared with the IRS.

Given the tenor of
the IRM, that the disclosure is too late if the
IRS already knows about the taxpayer’s
issues, the disclosure might (arguably) be
considered timely and voluntary even if the
taxpayer is a subject of a grand jury
investigation being conducted by a different
agency. This is not plain, however, and is a good
example of the type of scenario counsel might want
to present in a preliminary fashion before
disclosing the taxpayer’s identity.

Once
the disclosure is made, a special agent will
evaluate it. If the agent deems it to be truthful
and complete, he or she will so indicate to the
special agent in charge. According to the IRM, the
evaluation should be completed within 10 working
days from when it was received. The disclosure
doesn’t have to be communicated in any particular
format, but processing it will require information
outlined in IRM 9.5.11.9.6.

If the IRS
accepts the disclosure, it is agreeing to take it
into consideration in deciding whether to
recommend prosecution by the Justice Department.
If all other factors are met, the disclosure may
result in prosecution not being recommended.

HAZARDS MANAGEABLEFor many
CPA firms, apparent criminal exposure for their
tax clients may come up seldom, if ever.
“Thankfully, our firm does not have much
experience with voluntary disclosure,” said
Patrick H. O’Brien, a CPA with O’Brien, Riley
& Ryan PC in Westwood, Mass. “We require our
clients to provide us with the information
necessary to file complete and accurate returns.
In situations where clients come forward with
information indicating that they have been less
than truthful in the past, it becomes necessary to
carefully reconsider whether that client
relationship still makes sense.

“If we
decide to continue our relationship with the
client, we first encourage that the client
immediately retain legal counsel,” O’Brien said.
“After the client and his legal counsel have
reviewed all their options, we do believe that the
use of voluntary disclosure is a viable option
that should be considered and could provide
significant savings to the client. Most likely, we
may use the voluntary disclosure with a new client
or referral that is looking to get back on the
right track.”

There are generally few
risks to the CPA if the client makes a properly
counseled voluntary disclosure. If the IRS accepts
the disclosure, it would not be very interested in
the accountant’s role in any prior filings. Of
course, if the accountant knew of and participated
in prior filings of false tax returns, it would be
potentially problematic to have the client talking
to the IRS. In most cases, however, any
involvement by the accountant would be
sufficiently innocent that the IRS would not take
an interest.

Given the hazards built into
the voluntary disclosure policy, is it ever wise
to pursue a disclosure? These days, in particular,
the answer is “yes.” Law enforcement resources are
stretched thin, and with the Justice Department
focused on terrorism, the IRS is often happy to
get a taxpayer back in the fold without having to
launch an investigation. The taxpayer must simply
be aware of the rules and be candid with counsel
about his or her situation. While there are no
guarantees, practice reveals that properly made
voluntary disclosures are usually effective. As
long as the taxpayer is careful, he or she likely
will wind up poorer but still free, which
definitely beats poorer and in jail.

AICPA
RESOURCES

Conferences AICPA Practitioners Symposium, May
5–7, Las Vegas, “How to Negotiate
Persuasively With the IRS,” session on May
6

CPE Dealing with the IRS , a CPE
self-study course (#732263)

For
more information or to register, go to www.cpa2biz.com,
or call the Institute at 888-777-7077.

TAX NEWS

President Barack Obama signed legislation that retroactively extended more than 50 expired tax provisions for 2014, allowing taxpayers to take advantage of a host of tax incentives during this filing season.

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